A Blog About Current Issues in White Collar Defense

January 17, 2014

Bitcoin Goes Mainstream

By: Ifrah Law

As followers of trends in e-commerce, our firm takes a keen interest in new e-payment methods. Last year, we predicted the Bitcoin would emerge as an innovative mode of currency for online transactions. When Bitcoin – an alternative virtual currency – first appeared in the mainstream media, it was largely portrayed as a wonky, nerdy counterculture experiment in decentralized wiki-currency. Reports explained that it was based on digital cryptography, but few if any people actually understood the math and even fewer could explain it in language that was comprehensible to most of us. But things have changed, and it is a whole new Bitcoin world.

Recent reports actually treat Bitcoin like a part of the mainstream economy. Government officials testifying on Capital Hill warn legislators not to underestimate the value that Bitcoin brings to the economy. Even leaving aside the federal shutdowns of illicit sites like Silk Road (an eBay-like marketplace for illegal drugs), ever-growing numbers of businesses are accepting Bitcoin as payment. Online market Overstock.com and social gaming site Zynga.com have both indicated their intent to accept Bitcoin. The owner of the Sacramento Kings has announced that fans will soon be able to buy tickets and hot dogs using Bitcoin. And it even appears that it will be possible to make political contributions using Bitcoin – doubling down on the whole issue of transparency versus anonymity in campaign contributions.

So if your organization considers using or accepting Bitcoin, there are some significant considerations:

1. The value of Bitcoin is extremely volatile.

Individuals can exchange national (fiat) currencies for Bitcoin through a variety of exchanges that have popped up in response to the demand for such services. The prices on these exchanges vary considerably among themselves at any particular time, and the price of Bitcoin has fluctuated wildly over the course of the past year. One Bitcoin was worth about $13 a year ago (in January 2013); in November 2013, the price surged over $1000 per Bitcoin. For a period of time, people in China were reportedly using Bitcoin as a means to avoid currency restrictions in that country; when China issued a ban on Bitcoin, the price swooned, although it later recovered much of that value.

The volatility of Bitcoin obviously poses challenges for businesses that accept them. Some address the issue by setting prices in national (fiat) currencies, accepting payments in Bitcoin but exchanging them on a regular basis. Other businesses have proposed engaging in sophisticated hedging transactions to address this risk.

2. Bitcoin has regulatory uncertainty.

To even talk about regulations and Bitcoin feels like it cuts against the entire vibe of this alternative currency, but there is little doubt that it is coming. The Financial Crimes Enforcement Network (FINCEN) has stated unequivocally that Bitcoin exchanges (which exchange Bitcoin for fiat currencies) and most Bitcoin “miners” (which process Bitcoin transactions) must register as Money Services Businesses (MSBs) under Department of the Treasury regulations. And legislators in the U.S. Congress are unquestionably considering what regulations can and should be imposed on the currency in order to safeguard against abuses without extinguishing the innovation to which it is so closely tied.

3. Bitcoin is anonymous – sort of.

When Bitcoin first emerged in the public eye, it was ballyhooed – and demonized – because of its supposed anonymity. The belief that its users could indeed remain anonymous gave rise to marketplaces for drugs and murders for hire paid in Bitcoin. The rub is that Bitcoin is not entirely anonymous: The digital framework of the currency is that each transaction is recorded in the cryptography itself (preventing fraud such as spending the same Bitcoin twice), and it is possible in some cases to use that information to find one’s way back to a Bitcoin user. The combination of a belief in anonymity and the ability of law enforcement to identify users obviously poses risks related to anti-money laundering obligations of which businesses must be aware.

4. Bitcoin still has security issues.

The last, but possibly most serious, consideration about accepting Bitcoin is lingering questions about security. ­­­­Bitcoin are balances (credits) assigned to “addresses” (random strings of letters and numbers) that are publicly available. To spend the balance associated with a particular “address,” a user must have the corresponding “private key” (a slightly longer random string of letters and numbers) and apply a digital signature that allows some portion of that balance to be transferred to another address. Thus, the security of Bitcoin relies entirely on the security of “private keys”: Anyone who gains access to a private key gains access to the Bitcoin balance associated with that key. Given the recent headlines about data security breaches, it is not hard to understand why there might be concerns about accepting a virtual currency that can be purloined simply by stealing digital data from a computer.

The likelihood is that it is simply too early to judge whether Bitcoin is simply a fad or a harbinger of a sea change in our notion of what constitutes money and currency in a global digital world. Businesses who are early adopters may garner significant gains – or they may get burnt by early “learning experiences.” Inside counsel are wise to advise their clients about the risks and benefits of Bitcoin so that business leaders may make wise choices about the decision to accept them.